Dire differential: How to deal with the oil price discount costing Canada billions

Western Canada's oil companies must settle for a discounted price for their products thanks to production gains that have not been matched by export pipeline capacity gains. Larry MacDougal / The Canadian Press

Alberta oil producers are dealing with a brutal oil differential that’s costing Canada billions of dollars in lost revenue.

Premier Rachel Notley called it a “very serious problem” Thursday when the price for Western Canadian Select (WCS) heavy crude reached a record low, at one point dropping below US$14.

The price discount for WCS has been sitting at around US$40 a barrel.

“There’s a lack of consensus within the industry about the best way forward, meanwhile we have a suite of options at our disposal,” Notley told reporters. “We don’t want it racing out of the ground at $10 a barrel.”

Estimates to how much the differential is costing the economy vary — the Canadian Association of Petroleum Producers pegged it at at least C$13 billion in the first 10 months of 2018 and around C$50 million per day in October.

What are the options to reduce the differential?

Build a pipeline

The deteriorating Enbridge Energy Line 3 carries crude oil from Hardisty, Alta., through the U.S. to Enbridge’s terminal in Wisconsin. Enbridge has said the replacement project, which has been approved, would restore the pipeline’s original capacity of 760,000 barrels per day.

On Monday, Keystone XL was dealt a blow when a U.S. federal court decision blocked the construction permit and ordered officials to complete an environmental review. The Keystone XL pipeline would begin in Alberta and shuttle nearly 830,000 bpd of crude through the U.S. to terminals on the Gulf Coast.

Notley’s government has been touting the importance of the Trans Mountain pipeline expansion for months during a saga that most recently included a Federal Court of Appeal decision that stalled construction. The expansion from the Edmonton area to Burnaby, B.C., would nearly triple the line’s capacity to 890,000 bpd.

Cut production

Industry players can’t agree on whether to slash production temporarily in order to relieve the oversupply of oil. But the province also has the ability to step in and mandate cuts.

Cenovus Energy Inc. and Canadian Natural Resources Ltd. have endorsed that option, while Suncor Energy Inc. and Husky Energy Inc. rejected the idea of a government-imposed reduction.

If the industry cuts output by 200,000 to 300,000 bpd, it would take pressure off pipelines and normalize production levels, said Cenovus CEO Alex Pourbaix Thursday.

In an email Friday, the province said the bare-bones legal authority for an allocation system exists, but warned it wouldn’t be easy.

“Modern-day realities such as free trade agreements and integrated oilsands operations would make it far more complicated to simply institute a quota system,” said Mike McKinnon, spokesman for Energy Minister Marg McCuaig-Boyd.

“Any decision would need be made thoughtfully and respect the orderly regulation of today’s oil and gas sector.”

Increase crude-by-rail capacity

The NDP asked Ottawa to increase capacity for oil and gas on rail, calling it a short-term solution for the widening price differential. It could provide temporary relief for producers trying to transport oil outside of Alberta.

Crude-by-rail shipments increased to a record 230,000 bpd in August, but the differential continued to grow. Cabinet ministers said this week they are still waiting for a response from Ottawa.

Remove ‘air barrels’ from production

Canadian Natural Resources Ltd. president Tim McKay said earlier this month that the mounting differential is “exacerbated” by inefficiencies in how the crude oil pipeline traffic is controlled. He said energy industry members are interfering with attempts to make pipelines run more efficiently in order to make “windfall revenues.”

The industry’s Crude Oil Logistics Committee, which represents producers, refiners, shippers, pipeline owners and regulators, has the ability to adjust rules to optimize how pipeline space is assigned to members.

Full pipelines have led to shippers “nominating” more barrels than they can or need to ship in hope they will get more barrels out if Enbridge Inc. has to “apportion” space on its Mainline system, said analyst Jennifer Rowland of Edward Jones.

If the shipper doesn’t use all the space allotted, it results in “air barrels” going to market, she said. It means the industry isn’t getting the maximum amount of barrels out of Canada.

Enbridge has said export pipelines are running as full as possible and modifications to the nomination process won’t change that.

Do nothing

Analyst Phil Skolnick of Eight Capital said voluntary output cuts already announced by companies will curtail between 130,000 and 140,000 bpd of oil production.

In a report released Thursday, he said that should normalize crude inventories in Western Canada in less than three months, bringing stock piles back to 2014-15 levels.

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